Monday 11 December 2017

iPhone fears sour Apple shares

Apple's share price fell 6pc last week following third quarter results. Was this merely a hiccup - or are there deeper problems at its core?

Apple's share price fell 6pc last week following third quarter results. Was this merely a hiccup - or are there deeper problems at its core?
Apple's share price fell 6pc last week following third quarter results. Was this merely a hiccup - or are there deeper problems at its core?
Dan White

Dan White

Apple released its third quarter results on Tuesday. On the face of it the quarterly numbers from the world's most valuable company point to a business in rude good health - with sales up 32pc to $49.6bn (€45.2bn)and pre-tax profits soaring by 38pc to almost $14.5bn during the three months ended June 27. And just for good measure, Apple has no net borrowings but is instead sitting on a cash mountain of over $200bn.

However, despite these excellent numbers the Apple share price fell by over 6pc from $131 to $122 following the results announcement as investors focused on lower-than-expected iPhone sales - which were up "only" 35pc to 47.5m units in the third quarter compared to the 49m units that had been widely forecast by market insiders.

Matters weren't helped by the fact that Apple refused to break out the sales figures for its new Apple Watch, launched with much fanfare in April. Apple boss Tim Cook justified the company's refusal to share this information with the market on competitive grounds.

"We made the decision back in September not to disclose the shipments on the watch, and that was not a matter of not being transparent, it was a matter of not giving our competition insight [on] a product that we worked hard on."

All very reasonable no doubt but the fact that Apple had previously been prepared to release shipment data for its iPhone and iPad products at a similar stage in their life cycle will have done nothing to ease fears that the Apple Watch (Apple has been unable to use the iWatch name due to trademark difficulties) has been less successful than previous Apple product launches.

Analysts had been predicting Apple Watch shipments of 3.4m units. While Apple Watch sales added about $1bn to the group's total third quarter sales, it is generally reckoned that shipments fell well short of what the market had been expecting - certainly less than 3m units and possibly as few as 2.5m.

While shipping a billion dollars-worth of product in a single quarter means that the Apple Watch is hardly the flop that pessimists had feared, it is already looking like a niche business. Ironically the success of previous Apple products, its iPhone smartphone in particular, has contributed to the difficulties being experienced by the Apple Watch. How many under-40s now wear a wristwatch when they can tell the time by simply looking at their smartphone?

However, it is the shortfall in iPhone shipments that is the greatest cause for concern. With third quarter sales of almost $31.4bn - 63pc of the total - the iPhone is very much the beating heart of Apple. The company's fortunes are crucially dependent on the iPhone.

Berenberg Bank analyst Adnaan Ahmad has been a long-time Apple bear.

"The smartphone investment of the past three years is now a smartphone trade. This is very similar to what happened in the handset industry a decade ago, when volumes topped out in developed markets and were led by growth in emerging markets," according to Mr Ahmad.

Apple's growing dependence on the Chinese market lends at least some credence to these fears. While Apple's total third quarter sales were 32pc higher than in the same quarter of 2014, its Chinese sales leaped ahead by 112pc.

Apple sold $13.2bn worth of kit in China in the third quarter and a further $2.9bn in the rest of Asia except Japan. Between them these markets now account for almost a third of its total sales.

Deutsche Bank analyst Sherri Scribner also believes that Apple's growth is set to slow.

"We continue to remain concerned that Apple smartphone market share is peaking and expect iPhone unit growth to decelerate next year," she warned. "We continue to worry that recent iPhone strength and high market share are unsustainable."

Apple may be a victim of its own success. Under its iconic founder Steve Jobs, and following Jobs' death in 2011 his successor Tim Cook, Apple has ploughed its own furrow.

It has eschewed common industry standards, preferring to create its own "ecosystem" behind a "walled garden". It has created a string of beautifully-designed, if expensive, products that have acquired an incredibly loyal customer base.

Part of Steve Jobs' genius lay in his ability to create products that met needs his customers didn't even know they had before the product was first launched.

First there was the iPod, which transformed the music business following its launch in 2001. CD collections, which music aficionados had spent years building up, were immediately rendered obsolete by the cigarette packet-sized device that could store a virtually unlimited amount of music.

This was followed by the iPhone 2007. Sure there had been smartphones before the iPhone but they were clunky devices with tiny screens and miniature buttons whose use was virtually exclusively confined to an elite group. The iPhone, which came with a much larger screen and dispensed with buttons entirely, brought smartphones - essentially handheld computers - the masses.

Then there was the iPad in 2010. Computer users, who up to that point had been perfectly content with their PCs and laptops, suddenly couldn't get enough of the new, more convenient format.

This constant stream of innovative, new, must-have products transformed Apple from an also-ran into a tech titan. Its share price, even after last week's hiccup, has risen more than 20-fold over the past decade.

In 2012 it overtook oil major Exxon Mobil to become the world's most valuable company. Its market value stood at $721bn at the end of last week.

However, that was then and this is now.

There was a five-year gap between the launch of the iPad in April 2010 and the Apple Watch in April of this year. This has inevitably led to fears that, under Tim Cook, Apple has lost the Midas touch it possessed under Steve Jobs' leadership. While there have been regular updates of both the iPad and iPhone in recent years, the latest iPhone 6S is due to be unveiled in the autumn with an iPhone 7 some time in 2016, genuinely new blockbuster products from Apple have been somewhat thinner on the ground.

Apple has been toying with the TV market for almost a decade but it has yet to launch a product that catches the imagination of consumers in the same way that the iPhone or iPad have. There have been rumours of a new Apple TV in the autumn but it might be a good idea not to pitch one's expectations too high.

However, despite last week's stock market turbulence, it would be a mistake to overstate Apple's problems. Even in a "worst case" scenario iPhone sales will continue to grow for the foreseeable future - just not as quickly as had previously been expected.

"We believe continued iPhone volume growth can be driven by growing installed base and a high level of switching from Android [the rival Google-designed smartphone operating system], suggesting that the iPhone installed base will continue to grow and can provide unit growth ahead," writes Credit Suisse analyst Kulbinder Garcha.

Oppenheimer's Andrew Uerkwitz is even more bullish on Apple stating that:

"Apple's ecosystem appeal is only beginning to be understood by its customers and its growing portfolio of best-in-class services and peripheral devices will help the brand to sustain long-term share gain across hardware product categories."

The company's future prospects are also boosted by the fact that only 27pc of existing iPhone users have upgraded to the new larger-screen smartphones.

Given the fanatical loyalty of many iPhone users it seems a reasonable bet to assume that most of these will choose another iPhone when the time comes to upgrade their handset.

Apple's "problems" are of the kind that most companies would kill for: A still rapidly-growing market for its main product and a huge cash mountain. As the world's most valuable company, the challenge facing Apple is to manage the transition from the extremely rapid growth of the past decade to slower growth in the years ahead.

4,000 Irish jobs

As one of Ireland's largest private-sector employers, with over 4,000 staff, Apple's disappointing third-quarter results will be closely monitored by the Government and the IDA for any possible signs of fallout.

Apple opened its first Irish plant at Hollyhill on the north side of Cork in 1980. It's still there 35 years later- and with more than 4,000 staff Apple is second only to Intel as Ireland's largest multi-national employer. However, Apple's Irish operations - particularly their convoluted tax arrangements - have not been without controversy.

In May 2013 the US Senate Investigations Committee accused Apple of having struck "a sweetheart" deal with the Irish Government to pay a 2pc tax rate on profits routed through Ireland.

These allegations were strongly denied at the time by both the Revenue Commissioners and the Department of Finance. Unfortunately mud sticks and the EU Commission has announced an investigation into the matter, claiming that Apple's Irish tax arrangements constituted illegal state aid.

Apple has warned that an adverse ruling from the Commission could see it forced to pay a "material" amount in Irish back taxes. Even before the Commission ruling the Irish Government has already moved to scrap several of the mechanisms such as the "double Irish" that allowed Apple and other multinationals to route non-Irish profits through this country.

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